Rebalancing When Average Are Under or Over Market Prices(?)

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dillastarr
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Rebalancing When Average Are Under or Over Market Prices(?)

Post by dillastarr » Wed Aug 08, 2018 10:31 am

Dear Bogleheads community,

I hope you are doing well with your portfolios (PFs).
Also, I would appreciate your advice on my following situation.

My PF consists of two ETFs.
1. Vanguard Long-Term Bond ETF (BLV) (Targeted PF share: 10-30%)
2. Vanguard Small-Cap Value ETF (VBR) (Targeted PF share: 70-90%)

My next investment will amount to 500€.

My current PF looks as follows:
BLV balance: 1,747.31€ (PF share: 34.94%) - Current market price: 75.97€ - My average price: 78.86€
VBR balance: 3254.04€ (PF share: 65.06%) - Current market price: 120.52€ - My average price: 111.23€

As you can see, rebalancing to my base BLV/VBR distribution of 20/80 would mean selling BLV under my average price and buying VBR over my average price, which, in my eyes, would make absolutely no sense.

As for now, I would rather just buy seven more BLV shares for 531.79€, thus, further shifting my BLV/VBR distribution to 41.19/58.81. This way, I would further lower my average BLV price and have even more shares to sell when rebalancing to my targeted BLV/VBR distribution of 20/80 would make sense again.

What do you say to my approach? Would you rather put all the 500€ into VBR, despite its current market price being over my average price of it, for example?

All the best for you and your investments,

Alexander

AlohaJoe
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Re: Rebalancing When Average Are Under or Over Market Prices(?)

Post by AlohaJoe » Wed Aug 08, 2018 10:38 am

I don't understand what average price has to do with anything or why anyone should care whether it is higher or lower than the market?

I think what you are trying to say is "do you still rebalance, even when doing so would generate capital gains taxes"?

You'll probably that most people will
  • Rebalance slowly using new contributions
  • Make adjustments in tax-free accounts to rebalance
  • Rebalance in amounts that stay under various tax thresholds, i.e. maybe only rebalance $20,000 this year and another $20,000 in January.
  • Have doubts about whether the asset allocation they said they wanted is what they really want
  • Calculate how many actual dollars one is talking about; if we're talking about a few hundred dollars in taxes, I wouldn't hesitate to rebalance
  • Finally....hold your nose & rebalance.

delamer
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Re: Rebalancing When Average Are Under or Over Market Prices(?)

Post by delamer » Wed Aug 08, 2018 10:44 am

I don’t understand why the average price you’ve paid is important in this context.

Hopefully, over the long run, the prices you pay for all your new investments in these funds will be higher than your average.

Because that means that the value of the shares are increasing.

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grabiner
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Re: Rebalancing When Average Are Under or Over Market Prices(?)

Post by grabiner » Wed Aug 08, 2018 9:34 pm

What you are doing doesn't look like rebalancing; you seem to have changed your allocation. If your target was to hold 80% stock, you would not have 65% stock unless the stock market had lost more than half its value.

So, why are you increasing your stock allocation now? It may be the right move, but you should have a good reason. (For example, your risk tolerance might have changed because you now have a secure job, or you might be near the end of a period of dollar-cost averaging into the market.)
Wiki David Grabiner

dillastarr
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Re: Rebalancing When Average Are Under or Over Market Prices(?)

Post by dillastarr » Thu Aug 09, 2018 2:43 am

Hi!

Thank you for your responses!

My strategy and thoughts are as follows:

Let's say I buy 100 shares à 100€.
Now, the market price of the shares drops to 90€ and I buy 100 more shares.
Thus, my average price would have dropped from 100€ per share in my PF to 95€.
Hence, I - in a way - increase the probability of being able to sell shares with a gain.
Put differently, by averaging down my average prices, the market has to increase in
smaller amounts for me being able to sell shares with a gain.

Back to my PF:
Over the last quarters I've always only bought BLV shares (bonds), since BLV had been
consistently under my average BLV price, whereas VBR had always been ober my
average VBR price.
Thus, - though my BLV/VBR distribution target is 20/80 - I shifted it to the current
about 35/65.

Do you see my point?

Best,

Alexander

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BeBH65
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Re: Rebalancing When Average Are Under or Over Market Prices(?)

Post by BeBH65 » Thu Aug 09, 2018 2:54 am

Hello,

The mechanism that you describe is used while investing in individuel stocks.
You are also using terminology like "rebalancing" differently then we do.


A step back:
On this forum we are inspired by the Bogleheads_investment_philosophy.
One of the principles is Never_bear_too_much_or_too_little_risk. Risk tolerance is a key factor in creating an asset allocation (the percentage of stocks, bonds, and cash or cash equivalents).[note 1] that will allow investors to stay the course during the inevitable market downturns.

The split between equity and bonds is the main determinator of your risk and your return. We believe in keeping this stable and Stay_the_course.
Over time your investments will evolve differently and your AA will drift away from your desired %. Once you have your portfolio, it's important to maintain your targeted asset allocation. Rebalancing is the act of bringing a portfolio that has deviated from its target allocation back into line.

dillastarr wrote:
Wed Aug 08, 2018 10:31 am
As you can see, rebalancing to my base BLV/VBR distribution of 20/80 would mean selling BLV under my average price and buying VBR over my average price, which, in my eyes, would make absolutely no sense.
1- The price you paid for your investment is irrelevant (*). It is sunken cost.
2- as you understand from above it is important to remain as close as possible to your chosen AA of 80/20. If you have a new contribution of $500 this month then buy VBR. You will pay the market price, which is the consensus of what it is worth today.

If you keep rebalancing by adding the new money to the asset that is below target you will see that you will buy "low". You will buy the asset that lost most value recently (or at least did appreciate the least).

Maybe create a portfolio in Morningstar and perform the purchases according to the scheme above: each time buying the asset that is below your 80/20 target. I think it will show that you would have bought VBR "on sale" in februari. and since then already have a nice gain of >10% on this purchase.

Post back with the results and additional questions.
BeBH65. (only an investment enthusiast, not a financial adviser, perform your due diligence).

dillastarr
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Re: Rebalancing When Average Are Under or Over Market Prices(?)

Post by dillastarr » Thu Aug 09, 2018 3:17 am

Dear BeBH65,

Thank you for your quick response!
Eventually, I want to follow Jason Kelly's 3Sig strategy, which, eventually, is value averaging.
AA: Bonds/Stocks - 10 to 30/70 to 90
Stocks quarterly target: +3%.
Hence, if your stocks share is below 3%, you buy up to it. If it's over 3%, you either just buy bonds or sell stocks and
put this plus your quarterly contribution into bonds.

I'm aware of the Bogleheads strategy of a fixed AA of bonds/stocks - 20/80. Still, however, I would think that
right now, it might be even more attractive, long-run, to buy even more bonds, since their average price
has been consistently decreasing.
I'm still wary of increasing my average stock price within my PF, since, in my eyes, this would mean
decreasing my probability of return on stocks within my PF.
Put differently, if you stick to a 20/80 AA, even when bonds consistently decrease in price while stocks consistently
increase in price, aren't you giving away the chance of a huge forthcoming upward trend in bonds and downward trend
in stocks?

Best,

Alexander

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Re: Rebalancing When Average Are Under or Over Market Prices(?)

Post by pkcrafter » Thu Aug 09, 2018 11:09 am

Here's a previous discussion on Kelly's method for anyone who might be interested.

viewtopic.php?t=190514

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

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grabiner
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Re: Rebalancing When Average Are Under or Over Market Prices(?)

Post by grabiner » Thu Aug 09, 2018 7:47 pm

dillastarr wrote:
Thu Aug 09, 2018 2:43 am
Hi!

Thank you for your responses!

My strategy and thoughts are as follows:

Let's say I buy 100 shares à 100€.
Now, the market price of the shares drops to 90€ and I buy 100 more shares.
Thus, my average price would have dropped from 100€ per share in my PF to 95€.
Hence, I - in a way - increase the probability of being able to sell shares with a gain.
Put differently, by averaging down my average prices, the market has to increase in
smaller amounts for me being able to sell shares with a gain.
This does not make sense. Your goal is to optimize your total return, not your gain or loss on individual stocks or funds. What you paid for a fund is not relevant except for tax purposes.

Suppose that I have the same amount of money as you, and the same risk tolerance, but my money is all in cash (say, because I just sold a business). I will invest according to my risk tolerance. If you invest the same way as I do, then you will get the same returns; there is no reason for you to adjust your investments because of which investments went up or down.

There is a principle of rebalancing, but that is a separate issue. If 80% stock is your preferred allocation, and the stock market declines to give you 75% stock, then you should get back to 80%. If you have new money to invest, you can do this by buying more stock. But once that takes you up to 80%, any additional investments should keep you at 80%, so they should be 80% stock and 20% bonds.
Wiki David Grabiner

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